Businesses must maintain adequate funding to survive and grow. Financing activities, or the flow of cash to and from lenders and owners, provides insight into a company's financial health and capital management.
Businesses track the changes in their cash over a given period using a cash flow statement. A cash flow statement includes three sections: operating activities, investing activities, and financing activities.
The financing activities' cash flow section shows how a business raised funds and returned the money to lenders and owners. This section only includes financing activities.
Explaining financing activities
Financing activities are transactions between a business and its lenders and owners to acquire or return resources. In other words, financing activities fund the company, repay lenders, and provide owners with a return on investment.
Financing activities include:
- Issuing and repurchasing equity
- Borrowing and repaying short-term and long-term debt. This activity includes principal payments to lenders and vendors for most capital purchases, as well as the cost to issue debt. Interest payments are operating activities, not finance activities. Transactions with vendors for all other purchases, including operating leases, are also operating activities
- Paying dividends
- Other contributions from, or distributions to, owners
Cash flow from financing activities only tracks financing activities involving cash. An owner contributing a piece of land is one example of non-cash financing activity.
What cash flow from financing activities reveals about a business
Context is crucial when analyzing cash flow from financing activities. Savvy owners and managers ensure that cash flow from financing activities matches their business' unique needs.
A positive cash flow from financing activities shows that a business raised more cash than it returned to lenders and owners. This activity may or may not indicate effective capital management, depending on the specific business circ*mstances. Individual line items require similar consideration.
Significant debt or equity raises may be a healthy sign for a promising startup or a company planning a significant expansion. Those same transactions might cause concern for a mature company with few growth prospects.
Conversely, many circ*mstances may cause a large negative cash flow from financing activities. Struggling businesses forced to repay loans due to covenants, partnerships executing a planned wind-up, and maturing companies able to repay debt may all have similar cash flow from financing activities.
The line items in cash flow from financing activities also reveal changes in the capital structure of a business. Every business needs a particular mix of debt and equity. Analyzing cash flow from financing activities can show whether a company is on track to achieve its ideal capital structure.
How to calculate cash flow from financing activities
Calculate cash flow from financing activities for a given period using a simple formula.
Take the cash received from issuing equity and debt, subtract cash paid to repurchase equity and debt, and then subtract funds paid as dividends to calculate cash flow from financing activities.
Below is an excerpt of an example cash flow statement showing only the cash flow from the financing activities section.
ABC Company Cash Flow From Financing Activities:
- Common stock issued $200,000
- Notes payable issued $54,000
- Notes payable repaid ($149,000)
- Dividends paid ($50,000)
- Net cash from financing $55,000
Company ABC received $254,000 from its equity and debt issues. Subtract both the $149,000 of debt repaid and $50,000 of dividends paid to arrive at a (positive) cash flow from financing activities of $55,000.
Through financing activities, Company ABC increased its equity, decreased its debt, and paid just under half of the difference to ownership. The business retained the remainder for its use. These facts will reveal whether Company ABC managed its capital effectively when combined with the goals and circ*mstances of the business.
Understanding what financing activities are and how they are used to calculate cash flow from financing activities gives decision-makers insight into their businesses' financial health and optimal capital structure.
Find out more about Business Accounting
FAQs
Financing activities are transactions between a business and its lenders and owners to acquire or return resources. In other words, financing activities fund the company, repay lenders, and provide owners with a return on investment. Financing activities include: Issuing and repurchasing equity.
What are financing activities examples? ›
Financing activities examples include the issuance of shares and bonds, borrowing a loan, servicing debt, buying back shares, etc. Since these activities directly affect a company's capital structure, analysts and investors use this as a critical indicator of a company's financial health.
What is financial activities in cash flow statement? ›
Cash flow from financing activities (CFF) is a section of a company's cash flow statement, which shows the net flows of cash that are used to fund the company. Financing activities include transactions involving debt, equity, and dividends.
What is the definition of financial activities? ›
They are activities that involve the inflow or outflow of money. Examples include buying and selling products (or assets), issuing stocks, initiating loans, and maintaining accounts. When a company sells shares and makes debt repayments, it is engaging in financial activities.
What are the three types of financial activities? ›
There are three main types of business activities: operating, investing, and financing. The cash flows used and created by each of these activities are listed in the cash flow statement. The cash flow statement is meant to be a reconciliation of net income on an accrual basis to cash flow.
Where are financing activities? ›
The financing activity in the cash flow statement focuses on how a firm raises capital and pays it back to investors through capital markets. These activities also include paying cash dividends, adding or changing loans, or issuing and selling more stock.
Is giving a loan a financing activity? ›
If a company borrows money, this is a financing activity. There are some inflows from financing activities including borrowing money or selling common stock. Outflows from financing activities include paying the principal part of debt (a loan payment), buying back your own stock or paying a dividend to investors.
Which of the following would be classified as a financing activity? ›
Raising long term funds through bonds, stocks, and other financial instruments, repaying or taking a loan, and payment of dividends are classified as financing activities.
Is issuing stock a financing activity? ›
Issuance of common stock is a financing activity because it involves raising capital to fund the business. In issuing common stocks, the management sells a portion of the company ownership to the public.
Is purchasing equipment a financing activity? ›
The purchase or sale of a fixed asset like property, plant, or equipment would be an investing activity. Also, proceeds from the sale of a division or cash out as a result of a merger or acquisition would fall under investing activities.
Buying and selling investments are considered investing activities and not financing activities. This is NOT a financing activity.
What are two examples of cash inflows by financing activities? ›
(i) Cash Sales of Goods. (ii) Income Tax paid. (iii) Dividend Paid. (iv) Purchase of Fixed Assets.
What is the difference between financing and investing activities? ›
Investing activities refer to earnings or expenditures on long-term assets, such as equipment and facilities, while financing activities are the cash flows between a company and its owners and creditors from activities such as issuing bonds, retiring bonds, selling stock or buying back stock.
What are the 5 main activities involved in accounting? ›
Defining the accounting cycle with steps: (1) Financial transactions, (2) Journal entries, (3) Posting to the Ledger, (4) Trial Balance Period, and (5) Reporting Period with Financial Reporting and Auditing.
What is an example of a financing activity quizlet? ›
The primary types of financing activities are borrowing money, issuing shares of stock, and paying dividends.
Are dividends a financing activity? ›
Dividends paid are classified as financing activities. Interest and dividends received or paid are classified in a consistent manner as either operating, investing or financing cash activities. Interest paid and interest and dividends received are usually classified in operating cash flows by a financial institution.
Is common stock a financing activity? ›
Issuance of common stock is a financing activity because it involves raising capital to fund the business. In issuing common stocks, the management sells a portion of the company ownership to the public.
